Are cryptocurrencies inflation-proof? 

Ever since Bitcoin became a popular asset to trade, it has been widely recognized as a hedge against inflation. Investors have begun adding it to their portfolios to protect against wild market fluctuations and uncontrollable changes that could damage capital. It’s not for nothing that Bitcoin has been referred to as “digital gold”. Much like the precious metal, it was long believed that its value would remain largely the same, with only minor oscillations. However, 2022 has proved that digital money fluctuations are no joke. Over the course of the year, the price of Bitcoin fell by over 60%.

However, this changed at the beginning of 2023, and the values began to climb again. The Bitcoin price today, of nearly $22,000, is significantly higher than it was during November and December when it reached some of the lowest levels in its entire history. Some investors are optimistic that this trend will hold and that the price will steadily climb to the levels it had in 2020 and 2021. Ideally, this will happen at a measured pace, as cryptocurrencies need sustainable growth. Harsh oscillations only serve to destabilize the market and create a hype that cannot be controlled, which means that the prices spike even higher. Then, there’s typically a dramatic crash during which investors lose a significant portion of their capital.

However, the dreaded inflation of 2022 is not yet over. What does that mean for crypto? And what lessons can you learn as an investor from the events of the last year, should they repeat themselves?

2022 performance 

While bitcoin has seen bleak years before, notably in 2018, there are many who believe that 2022 was just as bad, if not worse, than previous events. After the Federal Reserve began raising the interest rates to combat inflation, the price dropped to approximately a third of its peak back in 2020 and then finished the year at around $16,000.

Some analysts have expressed the belief that the reason for the crypto spike during the first two years of the 2020s came as a result of particularly low-interest rates, making even risky holdings such as digital money more attractive for investors looking to give them a try. During this time, investors could borrow with little to no interest and diversify their portfolios by introducing digital currencies into the equation. However, liquidity rates dropped as inflation continued to climb, so the demand for assets continued to rise. This also results in the need for the investments becoming scarcer, and since Bitcoin is directly tied to supply and demand, sudden changes in this sector leave a deep mark.

Bitcoin and inflation

The undersides of the crypto market can be rather complicated to understand as a beginner trader. However, as a general rule, you should know that the coin was built as a means to fuel daily transactions. However, its role has changed and morphed over the years, and investors have long regarded it as a means to protect their portfolios against inflation. Its power on the crypto market is so extensive that its movements also influence the way altcoins behave. In order to get a good idea of how the market will be affected and how the other digital coins in your portfolio will hold up over a given time, you need to follow BTC’s movements.

However, Bitcoin’s status as a hedge against inflation was seriously marred over the last year. After it has shed a large part of its value, investors have become convinced that it isn’t actually that powerful in helping protect against price spikes. However, that is only a surface thing. When you take a more in-depth look at Bitcoin, its potential becomes crystal clear.

The influence on inflation 

While the cryptocurrency market was largely separate from traditional markets over the years, they have become more strongly bound together over the years. This is mainly due to institutional investors, who have the capacity to put in substantial amounts of capital and bring crypto to the forefront of their strategy. However, this has created an additional vulnerability in cryptocurrencies, as they have become more susceptible to overall fluctuations. Therefore, if the market falls, Bitcoin and altcoins are more likely to be affected as well.

Its scarcity and limited supply also determine Bitcoin’s price and inflation rates. BTC is programmed to have only 21 million coins in circulation. After this amount is achieved, mining will cease, and investors will only have the given amount to trade. Currently, around 19 million of these coins are already in circulation. Moreover, there’s a strictly defined structure for when coins are released, and fewer and fewer Bitcoins enter circulation every four years.

This process is known as halving. At first, when the blockchain was in its incipient days, miners earned 50 coins for successfully mining a block. Four years on, this amount was reduced to 25. Today, it stands at 6.25 coins. By May 2024, when the next halving is expected to occur, the amount will be reduced to only 3.125.

Is it inflation-proof? 

So, the big question remains, is Bitcoin an inflation-proof asset, or should you look elsewhere for a holding that can fit in those shoes? The main characteristic making Bitcoin successful as a hedge is its limited supply, which reduces the inflation risk, as the pool is constrained. It is also easily transferable, interchangeable and secure. All these characteristics make it quite similar to gold. Because of its decentralized nature, anyone can invest in it. However, compared to gold, which is subjected to government regulations.

Because Bitcoin is not directly tied to any nation, fiat currency or economy, it remains a worldwide asset class. It is a better option compared to shares, stocks or bonds since it is largely unaffected by traditional economic dangers and crashes. However, it might find its status challenged as it continues to enter the world of mainstream markets.

To sum up, you can consider that crypto, especially one that tends to be more stable, such as Bitcoin, has significant benefits. While it might not be completely immune to inflation, it is still stronger than its peers in this regard.